Her Name Was Rio (Tinto), She Was a No-Buy

It appears the bizarre commodity love triangle of BHP Billiton - Rio Tinto - PRC has come to an abrupt end as Billiton is now dropping its previous takeover bid for Rio. There will be no merger of the mammoth Australian mining firms. China can now rest from its efforts to frustrate this proposed pairing and the pricing power it might have created over China. In large part, this turn of events is due to spectacularly falling commodity prices. In contrast to earlier scenarios where continued global growth would occur due to a "decoupling" of the rest of the world with America's downturn, things have recoupled in spectacular fashion.

The story roughly goes like this, as you all know--nearly insolvent American consumers, battered by stagnant incomes and falling home and equity prices, have hit the wall. In turn, export-oriented economies like that of China have seen less demand for consumer goods. With less demand for consumer goods, China has less need for commodity exports such as coal to power its factories and steel to manufacture its export wares. Thus, the Aussie mining giants have also cut back. I sometimes need to pinch myself in thinking how, in such a short span of time, oil was over $140 a barrel in mid-July and is at about $55. The trajectory of other commodities has followed a rather similar parabolic pattern. These are interesting times. From Reuters:

Top mining giant BHP Billiton's decision to pull its $66 billion hostile bid [it was almost double at the height of the commodity spike] for rival Rio Tinto sent its debt protection costs sharply lower on Tuesday. Five-year credit default swaps on BHP Billiton tightened by 130 basis points to 305 basis points, although five-year CDS on Rio remained unchanged at 800 basis points amid concerns about the company's relatively higher debt levels, an analyst said. That means it costs 305,000 euros ($392,700) and 800,000 euros ($1 million) a year respectively to protect 10 million euros of each company's debt against default.

Meanwhile, BHP shares jumped more than a fifth in hectic London trading, while Rio Tinto slumped as much as 40 percent. [The acquiring company's existing shareholders would have suffered via share dilution from a merger, while those of the acquired company would have benefited from a higher bid price in order to attract their interest.]

Concerns about the all-share deal were centered on the ability of the companies to refinance their existing debt burden, ING credit strategists said. The decision was a high profile example that the credit crisis is crimping mergers and acquisitions, the bank added. "The greater debt exposure of the combination plus the difficulty of divesting assets have increased the risk to shareholder value to an unacceptable levels," BHP Billiton said.

BHP, which had already won U.S. and Australian regulatory clearance for a deal, said it had been ready to offer concessions to Brussels to secure the European Commission's blessing, but would not have been able to sell assets at a fair price in the current climate.

Rio Tinto had $42 billion in net debt at end June, after taking on $40 billion in debt to buy U.S. aluminum producer Alcan last year. The company also has around $8.9 billion of debt maturing in October 2009, which it has said will be paid off easily through its $15 billion asset disposal program. Credit rating agency Moody's Investors Service said earlier this month, however, that the planned asset sales by Rio to reduce debt would be slower than planned and could bring in less cash than hoped.

Moody's said it may lower its A3 senior unsecured rating on Rio as the company generates lower cash on the back of declining prices on key products such as copper, aluminum and iron ore, and as the company battles its high debt levels. It also changed its outlook to developing from positive.

Standard & Poor's rates Rio Tinto at BBB+ while Fitch has an A+ rating. By comparison, Moody's rates BHP Billiton at A1, while Standard & Poor's rates the company at A+.

BHP Billiton is one of the least-geared mining groups with net debt of $6.3 billion at the end of October, and has a portfolio of assets that is expected to deliver solid cashflows, the company said.

"BHP Billiton's priorities for cash flows remain to invest in its core businesses, manage its balance sheet to a solid A credit rating, maintain its progressive dividend policy and return any surplus cash to shareholders," BHP said.